We dive into the state of fixed income investing, given that market dislocation is influencing macro trends and the perpetual search for yield.
There are many different types of fixed income, even though we talk about it as a single asset class. We have everything from US Treasuries, or a Treasury yield curve, to asset-backed securities and structured corporate investment-grade and high-yield.
It’s constructive to gain some perspective and take a look at the market reaction to fixed income this year. US Treasury rates have been declining for the most part, although the 30-year is a little bit higher. But if we look a little further back to September last year, rates are up across the curve (a steeper curve). It appears the market is saying that there’s potential for inflation, and the U.S. Federal Reserve (Fed) is not going to cut as much from a Treasury view.
The Inflation Fight May Be Far from Over
Source: Bloomberg, as of 30 June 2025.
The Buzz About Spreads
Reviewing risk assets within fixed income, you look at credit spreads, which were tightening throughout most of last year. We finished the year with corporates in the top decile (tightest spread) for investment-grade and high-yield corporates. High yield was within about 70 basis points of its tightest ever, which was back in May 2007. But spreads widened out in the spring and got back to their post-financial crisis average.
Risky Fixed Income Spreads Are Relatively Tight
Source: Bloomberg, as of 30 June 2025.
And as we saw last year, the corporate spread, which is the additional yield over treasuries, was tightening all year. So, you’re getting nice price appreciation, but your compensation for taking risks is reduced. That pushed some investors further and further down in quality, pushing them to take more and more risk to try to maintain a higher yield or to get more spread or carry.
Securitized securities, which include MBS, CMBS, and ABS, weren’t tightening as much or getting as stretched in terms of valuation. And if you think about spread/additional yield over treasuries, it can only go so tight. So as things get tighter and tighter, your opportunity to see that continues to decline. In all, investment-grade spreads under 90 basis points and high-yield spreads under 300 basis points have historically translated into negative excess returns.
Spread Levels Not Compensating for Risk
Source: Bloomberg, as of 30 June 2025.
*Note: Data represents median forward 12-month excess returns for spreads daily back to 2000.
We saw some shifts to more opportunities in securitized. In commercial mortgage-backed securities, there was fear about increasing vacancies in office space. And there’s a view that all CMBS and all office is bad, but that’s not accurate. There are some great opportunities in office space, especially high-quality office space. There’s a lot of diversification in the space as well, like industrial warehouse, multifamily housing, and in the asset-backed space, which is much more consumer-oriented.
Talking About Dislocation
Aside from a little volatility earlier in the year, bond markets have behaved pretty well. It’s been a good overall investment environment with an occasion for some repositioning that allowed for some opportunity to take advantage of some of that dislocation, but the spreads rapidly tightened back in again. We’ve seen a lot of geopolitical risk, which would lead investors to think that there would be a big flight to safety and a selloff in risk assets, but it hasn’t really taken place. And rate volatility is significantly higher than spread volatility (as shown below), as the gap reveals some complacency in pricing in credit spreads.
Rate Volatility Higher than Spread Volatility
Source: Bloomberg, as of 30 June 2025.
Equities may be exciting, but we bond nerds like math and economics. There are a lot of opportunities and different ways to invest money in the fixed income side of things, whether it’s the formerly Triple-A, now double-A, US treasuries or our sovereign debt, or credit. Credit is non-U.S. governments, and that’s where you get some additional yield spread over the Treasury curve. And for U.S. corporates or securitized – breaks down into mortgages, agency mortgages, non-agency mortgages, commercial mortgage-backed securities, asset-backed securities, and things like collateralized loan obligations – that’s where you can get some additional yield or income, that spread amount of yield you get over treasuries.
Investors are getting nice price appreciation, but your compensation for taking risks is going down. That pushed some people further and further down in quality, taking more and more risks to try to maintain a higher yield or to get more spread or carry, being the additional year.
The Search for Yield
There’s a lot of demand for incremental yield globally, with a lot more investors who are relative value driven and understand how to ask the right questions. And we may never see the classic historical spreads, but higher yields have provided optimism for fixed income market returns going forward. Yields across fixed income are consistently above long-term averages (as shown below).
Rising Yields
Source: Bloomberg, as of 30 June 2025.
*Municipal yields are tax-adjusted and assumes a top marginal Federal bracket of 37% and Medicare surcharge of 3.8%.
Key Takeaway
If investors are looking to put some sidelined cash to work in the fixed income markets, we see this period as a great opportunity relative to the last 15 years. The potential for enhanced returns is decidedly more present.
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